“Overconfidence is the mother of all psychological biases.”
That sentence opens a short posting by Don Moore, a Berkley professor who wrote a book that explains “what confidence is, when it can be helpful, and when it can be destructive in our lives.” The quote also reveals a problem at the heart of many interactions among investment actors.
A paper from Broyhill Asset Management begins with this observation: “Absolute certainty does not exist in the wild. Yet, on Wall Street, overconfidence is pervasive.” The piece offers the definitions of certainty and uncertainty from Jason Zweig’s wonderful book, The Devil’s Financial Dictionary, before using the words of Richard Feynman to illustrate the appropriate (but rare) approach to a complex adaptive system like the one we inhabit.
Ian Toner of Verus wrote that our work “requires us to focus on skepticism: skepticism about markets, skepticism about counterparties, skepticism about investment claims, and skepticism about models.” He expanded on each of those angles of doubt. One reminder: “The pay available in the investment industry means that some of the brightest minds of our generation are devoted to creating compelling stories around no more than adequate investment products.”
Faking it
Given the ongoing trial of Elizabeth Holmes, as well as the bizarre happenings at Ozy Media, there have been many recent articles about the boundaries of the famous venture capital mantra, “Fake it till you make it.”
Of Holmes, one story said, “One of her strongest arguments may be that the only thing she was guilty of was optimism.” In a column about Ozy, Matt Levine wrote, “Here’s the thing about being a private company. You can sort of … say stuff.” The bar is lower than for public companies (although there are many examples of faking it in that realm too). One of the tailwinds for the SPAC boom in the last year is that you can sort of say stuff in marketing those transactions as well; the rules about making predictions are much more lenient than the ones for IPOs.
The broader issue
Bending the truth (or breaking it) is not limited to Silicon Valley or other venture hot spots. Confidence is something that is prized and sought out in the investment world. No one would say that they are looking for overconfidence — that mother of all biases — but that’s the end product much of the time. Confidence is the oil that lubricates decision making. Those who provide it tend to win the day, overshadowing those who seek to give a balanced, objective view of the possibilities.
A few examples:
A sell-side analyst, even one who is positive on a stock, gets less of a hearing with a buy-side portfolio manager (and his firm less of the trading flow) than an effective cheerleader who relentlessly promotes an idea.
Representatives of an asset management firm that talk with great confidence about their strategy are more likely to win business versus their competitors that speak frankly about the normal ebb and flow of both beta and alpha that should be expected. (Not surprisingly, that’s the case when those making the decision are volunteer trustees, but it is also true for professional allocators. They’re human too.)
When dealing with prospects, investment advisors are more likely to sell a vision of the future using comforting average statistics from the past rather than talking about fat tails, the wildness of markets, and the broad range of potential outcomes.
Even within organizations, it can be hard to be heard if you’re providing a balanced view. For example, recommendation reports for stocks and strategies and managers are written in ways that, as the old Johnny Mercer song goes, “accentuate the positive, eliminate the negative.” Or at least minimize the negatives, or stress how each one is “mitigated.”
We’re drawn to overconfidence — and then we end up being disappointed when reality intervenes.
Avoidance ideas
The tendency toward overconfidence is ingrained in us and designed into our relationships and organizations. Combating it is difficult.
Within your own organization, it comes down to the formation of beliefs about the problem, creating processes to shape the change, and having leaders that will drive the transformation so that someday it becomes an accepted part of the culture.
You are probably familiar with all of the standard recommendations on how to attack the problem of overconfidence, including the use of devil’s advocates, red team/blue team exercises, pre-mortems, post-mortems, etc. Ultimately, you need to build an environment where people feel free to surface disagreements and disconfirming evidence — and to remind each other of the uncertainties that lurk — in order to pierce the veil of overconfidence. To quote Feynman, “Doubt is not a fearful thing, but a thing of great value.”
While none of that is easy, it pales in comparison to the challenges faced when there is business on the line and your competitors are willing to feed a prospect’s desire for overconfidence.
While it does little good in the near term, one alternative is to position your approach as one free from the typical bluff and bluster. Just as a few companies have managed to play a different investor relations game than others — plain-spoken, focused on the long term, and intended to foster a base of quality shareholders who understand what the management team is trying to do — investment firms can take a similar tack.
Building that kind of a brand takes time, one that necessarily encompasses all of the communication channels of a firm and that infuses interaction after interaction into the future. Doing so can provide true differentiation from your competitors, something that is very rare. With effort, what is an apparent disadvantage can become a competitive advantage.
There’s one other card that can be played. While there’s no way to filter clients in publicly-available vehicles, you can do so with separately-managed accounts or partnerships or advisory relationships. No one wants to turn away paying clients, but selectively doing so may be the best policy (and could even create some scarcity demand).
The appetite for narratives brimming with confidence puts individual professionals in tough situations. There are temptations to stretch the truth or to leave out considerations that shouldn’t be left out. Taking the road less traveled will provide more stable ground on which to build a lasting relationship that fosters good decision making going forward.
Published: October 23, 2021
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